“Events, dear boy, events." That’s what former British prime minister Harold Macmillan responded when asked what he most feared.

Ask Treasurer
Joe Hockey
the same question today, and he would probably say that he fears what the Senate could do to his budget.

Ask him the same question again in 12 months’ time, and I suspect he will sound distinctly Macmillanish.

At the moment, Hockey probably feels that the government’s first budget was about as tough as politics can get.

First, he had to bridge the credibility gap that had opened up between the glad-handing style adopted by Prime Minister
Tony Abbott
on the hustings, and the reality of fiscal limitations upon taking office.

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Then he had to hose down the eruption of interest groups triggered by the release of the National Commission of Audit report.

Hockey’s fabled affability was wearing pretty thin by the time he actually delivered his budget speech to Parliament.

The budget and its provocative philosophy that the age of entitlement has ended provide convincing evidence that the government is prepared to back up its electioneering slogans with substantive action.

The budget begins to put our fiscal house back into a more sustainable order.

The same cannot be said for the rest of the world, where politicians have preferred to approach fiscal responsibility with populism disguised as compassion.

As a result, we have a global situation of slow growth and threatening deflation. The idea that we could be entering an extended period of secular stagnation is being seriously canvassed.

Australia, as a medium-sized, open economy is particularly vulnerable because of what have been up to now our greatest strengths – our resource endowments and proximity to the fastest-growing of all regions, Asia.

Looking at what could go wrong now, it is evident that the challenges facing Australia are greater than we have seen so far this century.

The first can be called the transition of Asia. Most of the time, we concentrate on what is happening in China. China is the anchor of the Asian region. Australia, for example, sells 26 per cent of its exports to China. However, the rest of Asia, including Japan and India, accounts for another 37 per cent.

China has been the engine room of Asian growth. Since it joined the World Trade Organisation in 2002, emerging Asia’s share of global gross domestic product has risen from 11 per cent to 21 per cent.

Being part of China’s supply chain has been important for the whole of Asia, but so too has the inflow of capital from Western economies, where interest rates have been held at record lows in an effort to stimulate local activity.

The slowdown of China is hurting export sales from the rest of Asia. There has also been a fall-off in Asian exports to the developed economies. For example, since the beginning of 2014, imports of consumer goods into the US have grown at less than half the rate of domestic spending, reversing a relationship that has held since the 1960s.

The Asian export boom underwrote high debt levels across most of Asia. Now the boom is fading, just as we are beginning to see higher interest rates.

Asia’s golden era, which can be dated from 2008, could end up in a debt trap.

Alarm bells ringing in China

China is still the anchor, but it is not the strongly growing economy of the past 30 years.

Producer prices have been falling there for 26 months and deflationary pressures are showing up in consumer indexes.

But it is property and debt that are the immediate concerns.

Barclays economist Jian Chang published a note to clients last week outlining three possible scenarios for China’s housing market.

Jian said Barclays’ base case was for a gradual deflating bubble over 2014-15.

In a second downside risk scenario, GDP growth would slow to between 6 per cent and 6.5 per cent this year and next.

Her worst-case scenario saw house prices tumbling by more than 30 per cent nationwide, leading to widespread defaults, insolvencies and bankruptcies as well as a liquidity crisis and GDP growth falling below 5 per cent.

Such remarks can be read in conjunction with unusually blunt warnings from the central bank.

In a blast at the wealth management industry last weekend, deputy governor Liu Shiyu said the sector had pushed up funding costs for Chinese companies, causing credit to be unpalatably expensive and distorting the economy.

He said “there is no contribution to labour productivity and it will lead a country’s financial system into short-term behaviour that is extreme in its gambling mentality".

Standard Chartered Bank estimated in January that the wealth management industry manages around 11 trillion yuan ($1.9 trillion) and is growing at an annual rate of 65 per cent.

Geopolitics a smokescreen for economic failure

Perhaps significantly, China’s domestic economic management problems have coincided with a distinctly more aggressive geopolitical stance in its relations with neighbouring countries over offshore drilling, mining and fishing rights.

Earlier this month China’s state-run oil industry positioned a deep-water drilling rig in the South China Sea off a speck of an island claimed by both China and Vietnam.

This was anything but an impromptu action. Positioning a billion-dollar rig takes months of preparatory organisation. Chinese naval vessels that engaged in ramming jousts with Vietnamese naval vessels accompanied the rig.

China has engaged in similar provocative actions against Japan and the Philippines.

Just what is behind these actions, beyond the rights mentioned above, is conjecture. However, it is far from unknown for a government facing domestic difficulties to distract attention with appeals to united national spirit in the face of an external threat.

Russia’s actions in effectively annexing Crimea, along with China’s initiatives, mark the return of geopolitics to the forefront of international discourse.

This is a development fraught with danger because of the potential to employ economic sanctions in a planet-wide space.

Because such weapons were successfully deployed against Iran, there is pressure to take the same action elsewhere.

The Russia-Ukraine situation underlines the spillover potential of a geopolitical misstep.

Russia is already on the verge of recession.

The European economy is also in a vulnerable position. Inflation, now being called slowflation, is running at 0.5 per cent and GDP growth is an anaemic 1 per cent.

The constant undermining of confidence about the future of Ukraine could be enough to tip the euro zone into recession.

The common denominator across the economies of Europe and Asia (along with the US) continues to be debt (both public and household) and political timidity. To those two we can now add geopolitical issues – events.